Why the Bulls Aren’t Doing Coke

My kids will probably never become big Coca-Cola drinkers. First, we’re not going to keep big 2-liter bottles of that kind of thing in the house and second, there are now so many alternatives to soda that what made Coke special to so many previous generations will probably be utterly lost on them.

During my routine run-through of large cap performance charts, I came across the old blue chip stalwart and was quite surprised. I couldn’t believe how poorly it’s been acting given the rising tide that’s been lifting nearly everything else. And don’t tell me that the “defensive” widows-n-orphan stocks are supposed to act badly in a risk-on tape – you’d be hard-pressed to find another high profile consumer staples stock that’s been dribbling its way lower over the last few months as Coke has.

In the below chart, you’re looking at two years of the SPY (S&P 500 ETF) and XLP (consumer staples sector SPDR) in blue and green respectively, with the glaring negative divergence in shares of KO below them (in yellow):

Coca-Cola stock is drowning despite the rising tide, frantically flailing away while buyers barely pay attention and sellers hit every bid. Despite the bounce of October, Coke remains mired in a downtrend – both on a relative and an absolute basis.

I’m pretty amazed, given the stature of the company and the iconic nature of its brand, that no one seems to want to talk about what’s happening here. When IBM reports a weak quarter, it seems to dominate the discussion on financial networks for at least half a day and it makes the homepage of nearly every financial website.

But we rarely hear a peep about its fellow Dow component, Coke.

So what’s going on?

For starters, it appears that there is a fundamental issue with the company’s bread-and-butter product, soda, that’s driving the weakening share price. The decline in soda sales in general is absolutely staggering. It’s been happening for almost a decade now and shows no signs of abating.

In April, the trade magazine Beverage Digest, noted that the soda category had officially entered its eighth straight year of decline. They noted that the amount of soda consumed worldwide in 2012 was now down to 1996 levels. Last year in the United States, soda consumption was back to 1987 levels! In fairness, Coke and Pepsi have been holding their own over this span, maintaining flat global soda sales while almost everyone else had seen a decline.

The trouble seems to be a close association between soda and obesity, especially in the west, but this does not explain the entire slide – sports drinks, energy drinks, juices and teas are also loaded with sugar and yet continue to expand. No, there is something soda-specific about this change in consumer tastes that should not be ignored. In addition, last week Pepsi admitted that the weakness in soda demand was also hitting its diet brands. Indra Nooyi, the CEO of Pepsi, revealed that “In the last six to nine months, there has been an accelerated decline in diet drinks as people say they don’t even want artificial sweeteners. The diet slowdown has been a little more rapid than we expected.” Dr Pepper Snapple, another rival, just reported a flattish earnings quarter and told analysts not to expect any sales growth over 2012 by the time 2013 is in the books.

Pepsi has been doing just fine amid the slowdown for soda sales in that half the company’s profit actually comes from its salty snacks biz, Frito-Lay. Coca-Cola doesn’t have this same yin-and-yang mix to hide the pathetic performance of its soda business and so its fortunes deviate drastically from those of its once-lesser rival. Soda accounts for 70% of Coca-Cola’s global sales while Pepsi derives only 33% of net sales from its beverage group.

This summer Coca-Cola told Wall Street that, while total volume was up 5%, the “sparkling” category – its sodas – saw volumes fall by 4%. This means that while Sprite and Coke and Diet Coke and other soda brands sell less product, the spring water division, Dasani, is helping to bail the company out. This has been a continuing trend for a long time.

And notably, as a sign of the times, Coca-Cola lost its status this September as the number one brand in the world to Apple. Coke had reigned atop this list for thirteen uninterrupted years. And while being the number two global brand is not too shabby, this loss is still a manifestation of the consumption trends I’ve just relayed.

The three biggest positives for Coca-Cola stock are, by now, well-known:

1. Warren Buffett remains committed (at 400 million shares or a $15 billion stake). In Berkshire Hathaway’s latest 10-Q we learned that their stake in KO had remained untouched – despite the large-scale selling Buffett has just done in fellow underperforming staple stock Kraft Foods.

2. Coca-Cola boasts fifty consecutive years of dividend increases (the current dividend yield is a respectable 2.87%) and a commitment to buy back shares (who isn’t these days).

3. The company has a global reach like almost no other company in world history, a priceless distribution and bottling network, massive brand awareness, and a storied history of finding new growth opportunities since the late 1800’s.

These are all incontrovertible facts, but they are likely more than priced in to Coca-Cola’s stock at the moment. KO currently sells for a premium premium multiple of over 20 times earnings and a price-to-earnings-growth (or PEG) ratio of 2.77. To put that latter number into perspective, Google’s PEG ratio is 1.95%, astonishing when you consider the differences in actual growth and opportunity for the ten-year-old web company vs the ancient Sugar Water King. In the meantime, analysts are looking for annual earnings of just $2.14 per share next year, virtually flat with 2013’s full-year expectations of $2.09.

Coca-Cola’s stock price has been in a downtrend since May and made a new year-to-date low in early October as the rest of the stock market was positively exploding to the upside. Some would point to Coke’s dependence on the emerging markets for all of its growth to explain the divergence from the US indices and I think that’s fair – up to a point.

The real question, to me, should not be about why people have been selling their shares of Coke all year. I think a more important question would be “What, if anything, will get people excited enough to ever want to buy Coke again, to take the stock to new highs and beyond?” When you consider the fact that Coke now enjoys less per capita consumption than it did five and ten years ago, this question becomes hard to answer.

I’m sure there’s solution out there somewhere – some innovation or potentially lucrative spin-off or transaction that could revive sentiment surrounding the name. But until then, its now regularly moribund earnings reports and lackluster stock performance stick out like sore thumb in the current environment – given its $172 billion market cap and Dow Jones Industrial Average berth, I’m amazed we’re not hearing more about it.

What do you think? Is Coke a cyclical bargain given the underperformance or have people turned away from soda forever on a more secular basis?

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